Regulatory Framework for Banks:

Reserve Bank of India

RBI, the Banking Regulator of India was

established on 1st April 1935 in
accordance with the provisions of
Reserve Bank of India Act, 1934

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 Banking Regulation in India
• Banks in India are regulated by Reserve Bank of India,
through the powers conferred upon it by the Banking
Regulation Act 1949.
• The Reserve Bank of India Act 1934 also empowers the RBI
to act on a wide range of issues including rules, regulations,
directions and guidelines with respect to banking and
financial services.
• RBI also draws its regulatory powers from the Foreign
Exchange Management Act (FEMA) 1999 and the Anti
Money Laundering Act.
• Cooperative banks are regulated by respective State Govts
under the State Cooperative Societies Acts.
• RRBs are regulated by NABARD.

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 The functions of RBI
• Making norms for opening and licensing of bank
branches
• Corporate Governance and organization of banks
• Norms for various banking products and services
• Formulation of Monetary Policy
• Regulation of foreign exchange market & Govt.
securities markets & financial derivatives
• Govt. debt and Cash management
• Overseeing payment and settlement systems
• Currency management
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 The functions of RBI contd
• Banking supervision is the most exhaustive role
of RBI
• RBI liaises with other financial service regulators
eg SEBI, IRDAI & DFS from the point of view of
regulating banking activities (which overlap with
other financial activities falling within the domain
of other regulators).
• DFS (Directorate of Financial Services, Govt of
India) prescribes norms for operation of public
sector banks and looks into the recovery of bank
loans through judicial and legislative measures.

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 Areas under RBI banking regulation
• Nature of business activities undertaken by
banks.
• Section 6 of the Banking Regulation Act details
the activities that a bank is permitted to
undertake including acceptance of deposits,
credit dispensation, investments, remittances &
collections, foreign exchange services, LCs &
guarantees, safe custody and vault services.
• As per Section 8 of the Banking Regulation Act,
banks are prohibited from trading in goods and
buying and selling of properties.

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 Licensing

• RBI has absolute discretion in the matter of

bank/branch licensing
• In September 2013, banks were freed from the
requirement of having to obtain prior approval of RBI
for opening branches subject to the condition that,
• 25% of the branches opened by a Bank in a year
should be in rural areas.
• Total number of branches opened in a year at
metropolitan centres should not exceed the total
number of branches opened in Tier 2 to Tier 6 centres
in the same period.

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 Capital adequacy

• RBI has prescribed that the capital and free

reserves of a bank should be at least 9% of its
risk weighted assets.
• Risk weights for different category of loans are
prescribed by RBI
• The capital adequacy requirement has made it
necessary for banks to access the capital market
or seek Govt. capital support periodically.
• Most Indian banks endeavour to maintain a
Capital Adequacy Ratio (CRAR) of over 10%
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 Account opening and KYC norms

• Banks have to ensure that Identity proof,

Address proof, of all prospective customers
are duly verified.
• Banks have to carry out necessary due
diligence in respect of high risk accounts viz
Non residents, HNIs, Trusts, NGOs,
companies having close family shareholdings
and politically exposed persons.

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 Compliance with Anti Money
Laundering Guidelines

• AML guidelines seek to prevent misuse of banking

channels for laundering black/dirty money
• Precautions required to be taken by banks include,
compliance with KYC guidelines, watch high value
transactions and verify the sources of funds, satisfy
about legitimacy of transactions, monitor & report
suspicious transactions, frequent cash transactions
just below the threshold limit, and senseless
transactions such as fund rotation amidst several
accounts or remittances to and from the same party.

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 Customer Service

• RBI has formed the Banking Codes & Standards Board

of India to set the standards of customer
service/amenities.
• The Code elaborates the rights of the customers vis a
vis the banking operations such as service charges,
hidden charges, role of third party selling agents,
compensation policy and cheque collection policy etc.
• Banking Ombudsman Scheme was introduced in 1995
as a system of grievance redressal by banks. The
awards of the Ombudsman can be reviewed by RBI.

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 Deposit Insurance

• With a view to protecting the interests of small

savers/depositors, RBI insists that all banks
should necessarily insure their deposits with the
DICGC (Deposit Insurance & Credit Guarantee
Corporation of India Ltd. ).
• DICGC guarantees repayment of deposits upto a
maximum of Rs 1 lac per customer in the event
of bank failure.
• Banks are required to pay DICGC Insurance
premium @ 0.1% per annum on the assessable
deposits of the Bank.

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 RBI direction on CRR and SLR
• RBI determines the rates of CRR and SLR
• CRR (Cash Reserve Ratio) - Banks have to maintain a specified
percentage of their Net Demand and Time Liabilities (NDTL) in the
form of cash in their account with RBI. RBI uses CRR as an
instrument of Monetary Policy. By increasing CRR, RBI can reduce
the availability of funds with banks and thereby tighten the liquidity
in the market. Current CRR is 4%.
• SLR (Statutory Liquidity Ratio) - All banks have to maintain liquid
assets in the form of cash, Gold & unencumbered approved
securities equal to & not less than the prescribed ratio of their
NDTL. SLR helps Govt. to mop up funds from the banking system by
issuing SLR approved securities. Current SLR is 19.5%
• NDTL= Bank’s Liabilities to others+ Liabilities to the banking
system- Assets with the Banking system. OR Aggregate deposits +
Deposits placed by other banks- deposits placed with other banks.

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 RBI Policy Rates
• Repo Rate - is the rate at which RBI lends short term
money to the banks. If RBI wants to make it more
expensive for banks to borrow money, it increases the Repo
Rate. Current Repo Rate is 5.15%
• Reverse Repo Rate - is the rate at which RBI borrows short
term money from banks. An increase in Reverse repo Rate
means that banks will get a higher rate of interest from RBI
as a result of which they will prefer lending to RBI with Zero
Default Risk, rather than to the public with higher default
Risk. Current Reverse Repo Rate is 4.90%.
• In other words, Repo rate signifies the rate at which RBI
injects liquidity in the system while Reverse repo rate
signifies the rate at which RBI sucks liquidity from the
system.
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 RBI Policy Rates (contd)- Definition
• For banks, Repo is an instrument for borrowing funds
from RBI by selling Govt. securities with an agreement
to re-purchase the said securities on a mutually
agreed future date at an agreed price, (which includes
interest for the funds borrowed).
• For banks, Reverse Repo is an instrument for lending
funds to RBI by purchasing Govt. Securities, with an
agreement to re-sell the said securities on a mutually
agreed future date at an agreed price (which includes
interest for the funds lent).

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RBI Guidelines on credit extension
• RBI guidelines have been issued on the entire domain of
credit extension by banks.
• Retail credit, covering Home Loans, auto loans, unsecured
loans, LTV ratios, EMI-NMI ratios and credit scoring models.
• Commercial Credit, covering financial statement analysis,
Ratio analysis, working capital & Term financing, export
and import financing.
• Rural credit, including financing of Agriculture and allied
activities, minor irrigation, warehouses & cold storages,
polyhouses & Greenhouses, etc.
• Micro Finance including finance to cottage & village
industries, Self Help Groups and Joint Liability Groups.

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 RBI Guidelines on Risk Management
Systems in Banks
• RBI guidelines have been issued for
implementation of policies and procedures for
measurement and control of various risks
assumed by banks in their day to day operations,
including
• Credit Risk
• Market Risk, including Interest rate risk and
foreign exchange risk
• Operational risk &
• Risk relating to Off Balance Sheet exposures

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 RBI guidelines on IRAC classification
of loans and NPA control
• Banks are required to classify their irregular/overdue
advances as NPAs (Non Performing Assets).
• Cash credit Accounts which are out of order for over 3
months or Term Loan accounts where instalments or
interest servicing are overdue for a period beyond 3
months are classified as NPA
• The NPAs have to be further sub classified as
Substandard, Doubtful or Loss assets.
• NPAs have a dual adverse impact on banks, eg
• 1. first there is no income recognition possible and,
• 2. second, there is an added provisioning requirement.

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 Provisioning on NPAs
Category of Asset Definition Provisioning requirement

Sub standard NPA for 1 year 15% of amt. outstanding

Doubtful 1 NPA from 1 to 2 years 25%

Doubtful 2 NPA from 2 to 3 years 40%

Doubtful 3 NPA above 3 years 100%

Loss Asset Where security has eroded 100%

entirely or loss has been
identified

Standard Assets 0.40%

Standard Assets – Farm 0.25% 18
 Banking Supervision by RBI
• With a view to separating the banking and supervisory
roles of RBI, the Department of Banking Supervision
(DBS) was created in 1993.
• The Department was carved out into a separate Board
for Financial supervision (BFS) in 1994. The BFS carries
out banking supervision in two ways,
• 1. On site verification involving physical examination of
banks’ documents and files
• 2. Off site surveillance & monitoring, which is based
on various quarterly reports being submitted by banks.

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Banking Supervision by RBI contd.
• The BFS has adopted the Risk based supervision (RBS)
model which involves the developing of risk profiles of
banks and calibrating the supervisory effort
accordingly.
• Based on the risk profiles so developed, the BFS draws
up a Monitorable Action Plan (MAP).
• In case the bank does not show cognizable
improvement based upon the MAP, RBI can initiate
Prompt Corrective Action (PCA) which includes curbs
on expansion activities and curbs on doing specific
types of businesses.
• NBFCs also fall within the supervisory control of RBI.

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 Other functions of RBI-
Monetary Authority
• As monetary Authority, RBI formulates and
implements the monetary policy of the
country.
• As controller of money supply, credit and
interest rates, RBI’s main objective is to ensure
price stability, economic stability, and
promote growth by ensuring adequate credit
to the productive sectors of the economy.

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 Other functions of RBI (contd)-
Manager of Foreign exchange
• RBI is vested with the authority for enforcing
FEMA (Foreign Exchange Management Act).
• Towards this end, RBI issues directives and
guidelines for banks and customers in handling
foreign currency transactions, including foreign
currency lending and borrowing.
• The objective of RBI is to facilitate orderly
development of foreign exchange market in
India.
• RBI also manages the foreign exchange reserves
of the country.
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 Other functions of RBI (contd)-
Issuer of Currency
• RBI is the sole authority for the issue of currency in the
country (except one rupee coins which are issued by Govt
of India).
• All the currency issued is the monetary liability of RBI and
is backed by assets of equal value which are held by the
Issue department of RBI.
• After the issuance of currency by the Issue department, the
Banking Department of RBI called DBOD takes care of the
currency in circulation and its withdrawal from circulation.
• RBI also manages the Foreign Exchange Reserves of the
country. Current Forex reserves of the country are USD
41.48 Billion.

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 Banker to the Govt. and Banker to
other banks
• As the Central Bank of the country, RBI manages all
the banking transactions of the Govt and deals in
foreign exchange. The Govt keeps its Current account
balances with RBI.
• RBI provides short term credit to the Central Govt.
which helps the Govt. to meet any shortfalls in its
receipts over disbursements.
• RBI also provides short term credit to State
Governments.
• RBI provides short term credit to commercial banks
and provides centralized clearing and quick
remittance facilities.

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THANK YOU

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 Credit Risk in Investment Banking
Due Diligence
• Entry level parameters (indicative for a Bank)
• Current Ratio- 1.33 or higher
• Debt Equity Ratio- Maximum 2.50
• Average DSCR- Above 1.25 (DSCR = Cash
accruals/ Term Loan repayment obligation)
• Prescribe upper ceiling in respect of Non SLR
investments in PSU bonds- (say 20% of total
investments)
• Cap on total Non SLR investments- (say 25% of
total Investments portfolio).

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 Risk Management Systems in Banks
Credit Risk Management
• Credit risk manifests in the form of default in
repayment in case of direct lending,
crystallization of NFB (Non Fund based)
liabilities and default in payment by
counterparty in case of investment products.
• Measurement of credit risk through Credit
Rating: Credit rating covers Financial Risk,
Industry Risk and Management Risk. CRAS is
utilized for tracking the migration of borrowers
from one rating category to another.

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 Prudential Exposure Ceilings
• Prudential credit exposure ceilings are prescribed in
the Loan Policy of Banks, which are revised from time
to time.
• The exposure ceilings are Industry specific as well as
Borrower/Group specific
• Industry Concentration Limits are fixed which
prescribe the total permissible exposure to an
industry in relation to Bank’s Total Non food
credit/Net worth.
• Loan Review function is being discharged by the banks
so as to track the credit quality of each exposure.

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 Credit approving authority
• A multi Tier credit approving system is in
place.
• All powers for credit sanctions are vested with
Committees constituted at different levels like
Regional level, Zonal level and LHO level.
Corporate Centre Credit Committees also look
into high value credit proposals.
• A system of review of all loans by a one stage
higher authority/Committee is also in vogue.

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 Credit appraisal system
• Elaborate guidelines have been issued by the
RBI for appraisal methodologies for working
capital and term loan finance, benchmark
financial ratios and norms for coverage by
collateral security.
• Scrutiny at pre-sanction stage and promoters’
track record and stake in the project are also
looked into

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 Credit Risk in Investment Banking
Due Diligence
• Entry level parameters (indicative for a Bank)
• Current Ratio- 1.33 or higher
• Debt Equity Ratio- Maximum 2.50
• Average DSCR- Above 1.25 (DSCR = Cash
accruals/ Term Loan repayment obligation)
• Prescribe upper ceiling in respect of Non SLR
investments in PSU bonds- (say 20% of total
investments)
• Cap on total Non SLR investments- (say 25% of
total Investments portfolio).

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 Market Risk
Liquidity Risk
• Liquidity represents the ability to meet the
decreases in liability and to fund the increases in
assets. Liquidity Risk manifests into:
• Funding Risk- Need to replace unanticipated fund
outflows (deposit withdrawals or sudden higher
availment of credit limits )
• Time Risk- Need to compensate for non receipt
of expected inflows (stunted deposit growth or
non- repayments of loans)
• Call Risk- Crystallization of Contingent Liabilities
(ie Devolvement of LCs or Guarantees)
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 Liquidity Risk Contd
• RBI Guidelines prescribe a quarterly Statement of Structural
Liquidity wherein all cash flows are bucketed into Time Buckets in
terms of their actual/expected maturities. (1-7 days, 8-14 days, …)
• Thereafter the Gaps in outflows (maturing liabilities ) & inflows
(maturing assets) are worked out which represent the
deficit/surplus likely to arise in future.
• RBI prescribes that banks should endeavour to broaden their base
of long term resources consistent with their long term assets and
commitments.
• The Tolerance limits on maturity mismatches prescribed by RBI are
as under;
• (a) Long Term Resources should not fall below 70% of Long Term
assets.
• (b) Long & Medium term resources should not fall below 80% of
Long & Medium Term assets.

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 Interest Rate Risk (IRR)
• IR Risk refers to the potential impact on profitability (NII)
caused by unexpected changes in Market interest rates.
• Banks review their IRR exposure periodically based upon a
Maturity Gap Analysis of their interest rate sensitive
assets & liabilities.
• A great deal of interest rate risk is inherent in the
investment portfolio of a bank because long duration
investments are vulnerable to IRR.
• As a measure of prudence, Banks classify their investments
into HTM, AFS and HFT categories.
• Duration Analysis of the Investment portfolio, with
suitable benchmarking is done as a control measure.

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 Foreign Exchange Risk
• Risk in forex transactions arises when there is over-
bought/ over-sold position in respect of currencies
which are likely to appreciate/depreciate.
• Risk of holding Open Positions in forex transactions
increases in times of foreign exchange volatility.
• Banks endeavour to control forex risk by the following
methods;
* Fixing intra-day/overnight Open position limits,
* Restricting forex trading to worthy counterparties and
*Fixing Stop Loss limits in respect of all trading
currencies.

35
 Operational Risk
• Operational Risk arises from breakdown in
Internal Control Mechanisms, non-adherence to
systems and procedures, human errors, frauds
or failure to perform duties in a timely manner.
• Technological failures are the major originator of
Operational Risks.
• Banks endeavour to control Operational Risk by
Internal Audits and IT Security Audits,
preventive Vigilance systems and Training
system. Most banks have introduced Risk Based
Internal Audit systems.

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 Risk Management Systems in Banks
Credit Risk Management
• Credit risk manifests in the form of default in
repayment in case of direct lending,
crystallization of NFB (Non Fund based)
liabilities and default in payment by
counterparty in case of investment products.
• Measurement of credit risk through Credit
Rating: Credit rating covers Financial Risk,
Industry Risk and Management Risk. CRAS is
utilized for tracking the migration of borrowers
from one rating category to another.

37
 Prudential Exposure Ceilings
• Prudential credit exposure ceilings are prescribed in
the Loan Policy of Banks, which are revised from time
to time.
• The exposure ceilings are Industry specific as well as
Borrower/Group specific
• Industry Concentration Limits are fixed which
prescribe the total permissible exposure to an
industry in relation to Bank’s Total Non food
credit/Net worth.
• Loan Review function is being discharged by the banks
so as to track the credit quality of each exposure.

38
 Credit approving authority
• A multi Tier credit approving system is in
place.
• All powers for credit sanctions are vested with
Committees constituted at different levels like
Regional level, Zonal level and LHO level.
Corporate Centre Credit Committees also look
into high value credit proposals.
• A system of review of all loans by a one stage
higher authority/Committee is also in vogue.

39
 Credit appraisal system
• Elaborate guidelines have been issued by the
RBI for appraisal methodologies for working
capital and term loan finance, benchmark
financial ratios and norms for coverage by
collateral security.
• Scrutiny at pre-sanction stage and promoters’
track record and stake in the project are also
looked into

40
 Operational Risk
• Operational Risk arises from breakdown in
Internal Control Mechanisms, non-adherence to
systems and procedures, human errors, frauds
or failure to perform duties in a timely manner.
• Technological failures are the major originator of
Operational Risks.
• Banks endeavour to control Operational Risk by
Internal Audits and IT Security Audits,
preventive Vigilance systems and Training
system. Most banks have introduced Risk Based
Internal Audit systems.

41
 Market Risk
Liquidity Risk
• Liquidity represents the ability to meet the
decreases in liability and to fund the increases in
assets. Liquidity Risk manifests into:
• Funding Risk- Need to replace unanticipated fund
outflows (deposit withdrawals or sudden higher
availment of credit limits )
• Time Risk- Need to compensate for non receipt
of expected inflows (stunted deposit growth or
non- repayments of loans)
• Call Risk- Crystallization of Contingent Liabilities
(ie Devolvement of LCs or Guarantees)
42
 Liquidity Risk Contd
• RBI Guidelines prescribe a quarterly Statement of Structural
Liquidity wherein all cash flows are bucketed into Time Buckets in
terms of their actual/expected maturities. (1-7 days, 8-14 days, …)
• Thereafter the Gaps in outflows (maturing liabilities ) & inflows
(maturing assets) are worked out which represent the
deficit/surplus likely to arise in future.
• RBI prescribes that banks should endeavour to broaden their base
of long term resources consistent with their long term assets and
commitments.
• The Tolerance limits on maturity mismatches prescribed by RBI are
as under;
• (a) Long Term Resources should not fall below 70% of Long Term
assets.
• (b) Long & Medium term resources should not fall below 80% of
Long & Medium Term assets.

43
 Interest Rate Risk (IRR)
• IR Risk refers to the potential impact on profitability (NII)
caused by unexpected changes in Market interest rates.
• Banks review their IRR exposure periodically based upon a
Maturity Gap Analysis of their interest rate sensitive
assets & liabilities.
• A great deal of interest rate risk is inherent in the
investment portfolio of a bank because long duration
investments are vulnerable to IRR.
• As a measure of prudence, Banks classify their investments
into HTM, AFS and HFT categories.
• Duration Analysis of the Investment portfolio, with
suitable benchmarking is done as a control measure.

44
 Foreign Exchange Risk
• Risk in forex transactions arises when there is over-
bought/ over-sold position in respect of currencies
which are likely to appreciate/depreciate.
• Risk of holding Open Positions in forex transactions
increases in times of foreign exchange volatility.
• Banks endeavour to control forex risk by the following
methods;
* Fixing intra-day/overnight Open position limits,
* Restricting forex trading to worthy counterparties and
*Fixing Stop Loss limits in respect of all trading
currencies.

45
 Adoption of scientific Risk
Management practices by Indian
banks
• In pursuance of RBI Guidelines, Risk Management
systems have been implemented by Indian Banks.
• These systems have been designed to enable
banks to identify, evaluate, monitor and control
the risks assumed by the banks in the different
areas of their operations including Credit Risk,
Market Risk, Operational Risk and Risk relating
to Off Balance Sheet Exposures.

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